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CHAPTER 3: PRINCIPLES OF FUTURES - Coggle Diagram
CHAPTER 3: PRINCIPLES OF FUTURES
Part 1: Basic Requirements for a Viable Futures Market
Deep market
Easy grading
Free fluctuation
Active Participation
Part 2: Contract specifications
Contract size
the number of units or amount represented by each futures contract
Price quotations
future prices are quoted in the same basic unit as its underlying instrument
Expiry date
the last day of trading in a particular contract month and hence, futures contract ceases to exist after the expiry date.
Contract month
traded on the basis of specified contract month, which is simply the month of maturity or epiry
Grade or quality
specified in futures contracts to ensure that participants trade the same type and quality of underlying instrument
Part 4: Commodity futures VS Financial futures
Commodity futures
- The futures which the underlying assets are the commodity products.
Financial futures
- Futures contracts which the underlying assets are the financial products
Part 3: Ofsetting VS Settlement
Ofsetting
- futures contract can be closed-out simply by taking the opposite position, or a contra to the original position
Settlement
- any outstanding contract, which has been closed-out, must be settled at maturity
Physical settlement
settlement by delivering the physical underlying instrument
Cash settlement
Settlement by paying the amount of cash equal to the exercise price of the futures
Part 6: Trading Practicalities
Basis
The difference between the cash price (spot price) of the underlying instrument (physical) and the futures price (contract)
Convergence
Cash and futures price move in tandem , that is, they are moving in the same direction, though not by the same amount
Both price will converge at one price at the date of maturity and hence, known as maturity price
Margin requirement
Margin payment is a legal requirement for every participant, be it the buyer or seller
To ensure that traders have sufficient funds to cover their position in the market
The clearing house requires members to deposit and maintain margin against their positions
Volume and Open Interest
Volume
Volume of trading has to be defined further as the total of purchases or sales for a given contract month.
Open interest
The number of outstanding contracts for a given contract month
Long Position vs Short Position
Long position
The long position agrees to buy the assets when the contract expires
Buying today at a lower price and expects to sell later at a higher price prior to or at maturity
Short position
Agrees to sell the assets when the contract expires
Selling today at a higher price and expects to buy back later at a lower price
Open position vs Close out position
Open position
The trader hold the futures contract until the expiry date
The holder need to make delivery of the assets or cash settlement
Closing position
Closing out a position means entering into the opposite type of trade from the original one
Part 5: Market participants
3) Spreader - Speculator who has dual positions or contracts at one time
Inter- Month Spread - the simultaneous buying and selling similar underlying instrument and contract month futures at different markets
Inter-Commodity Spread - the simultaneous trading of the same commodity and market but at different contract months is called inter-month spread
Inter-Market Spread - the simultaneous buying and selling similar underlying instrument and contract month futures at different markets
4) Arbitrageur - Investors who have dual positions at one time, that is buying futures and selling physical, and vice-versa
2) Speculator - The non-owners of physical commodity or financial instrument and they are not involved in the true business but are motivated by profits based on favorable price movements within specified period of time
1) Hedger - The actual owners of physical commodity of financial instrument